Jacob Austin (00:00:17) - Hi all, Jacob Austin here. Owner of QS.Zone. And welcome to episode 21 of the Subcontractors Blueprint, the show where subcontractors will learn how to ensure profitability, improve cash flow, and grow their business. You're listening to episode 21 and it's about risk and risk management. This is a subject that I don't think gets spoken about enough on construction projects, and I think the management of risks can be improved. And there's a lot to be said about the apportionment of risk between different contracts and the parties to those contracts both upstream and downstream. So let's start by trying to define risk. One simple way to view it would be the uncertainty of any given outcome. And that can manifest itself in a positive fashion whereby you have opportunity or a negative fashion where you've got a threat or you've got risk of loss. And you could think of that in basic terms as something akin to a game of snakes and ladders. You're rolling the dice so you've got an uncertain opportunity or an uncertain risk of threat. You're always rolling positive numbers.
Jacob Austin (00:01:23) - So the likelihood in general is that you will advance. But there are objects along the way which will either advance you further, in which case you make even more money. You get further up the board or you slide backwards making less money and going further down the board. Each company will have their own view of what an acceptable level of risk is. Some will be happy enough to take additional risks, so as long as there are additional rewards to be made or gains to be made, whereas others just want the certainty of getting to a certain outcome, and for them, mitigation of risks and passing on and selling of those risks is more important so that they're not incurring losses. Even if that does mean that the opportunity to make more money is diminished, it's that overall level of risk that somebody is willing to take which forms their risk appetite. And going back to our game, you might think of that in terms of certain organizations would try to only play the game if there are more ladders than snakes. In construction terms, the risk during a project diminishes the further you are in the process before you've started.
Jacob Austin (00:02:29) - Obviously, the more unknowns there are that could manifest themselves in the project. And obviously by the time you finished, hopefully there's no chance that something's going to go wrong. Then we'll just ignore the bit about latent defects for the time being. And let's just say that once you've handed the job over, you've made your money and nothing else bad can happen. There are a few ways to deal with risks. We can just accept that the risk is there and tolerate it. We can try and introduce measures to constrain, reduce and mitigate risks. We can transfer the risks to somebody else. That might mean through procurement, that might mean through an insurance policy. And of course, we can terminate whatever activity it is that's going to expose us to that risk altogether. And it goes without saying there are risks in life that you just can't mitigate. We've all heard some cynics talking about risks and saying that there's a risk as you're walking down the street of a plane, falling down and crashing on your head as a risk, as you're waiting at the crossings of a car, swerving and knocking you over, there's a risk of you falling over and breaking your leg.
Jacob Austin (00:03:33) - And to truly expose yourself to no risk at all is to sit and do nothing. And that is in part the reason for the phrase you've got to speculate to accumulate. There is inherent risk in everything and to have no risk at all. It also means you have no reward. And of course, the reason why you're in business is because you want that reward. So it stands to reason that you have to accept a level of risk. So as a subcontractor, you've got to understand where your risks are coming from and then decide which ones of those you're willing to keep, which ones you want to try and mitigate some of the risk of. And it may be the case that you want to turn off that tap altogether and reduce and eliminate your exposure to some. So let's start with the very first document. You're likely to receive your inquiry document. That should tell you straight away about one key area of risk. And that's to do with your price. How fixed does your price need to be? Starting at the riskiest end, you've got the fully fixed lump sum, which might be fixed for the duration of the subcontract works, but that might mean to you that you end up holding on to the price and inflation risk for a longer period of time than you anticipated, i.e., there is some risk that you get delayed, that you might not be able to recover from your contractor.
Jacob Austin (00:04:44) - And then for that delay period, you might be on the hook for the unknown factors of inflation. You've got target cost arrangements. And the level of risk differs in these kind of contracts because depending on how the risk is shared, you are set a target cost at a particular level, which you then go on and adjust throughout the job for changes, variations and the like. And what you then have to do is manage your costs so that it falls within that target. And then depending on the kind of contract that you're working on, you might have a differing level of pain and gain share and just throwing some figures around. If your costs come in underneath the target and assuming that your overheads and profit are ringfenced, then you might split 50:50 with the contractor. Any difference between that fully adjusted target cost. And by adjusted I mean it's got the variations added to it and your actual cost. And again, depending on the relationship between all of those numbers will depend on how much of the gain share you can get your hands on, and it's actually an opportunity to then enhance your margin on the job.
Jacob Austin (00:05:46) - Whereas target cost arrangements when they're working in the opposite fashion. When your cost is now exceeding the target, there is often a mechanism in place to say beyond, say, 105% of the target, then you carry the burden for any excess cost. You've also got remeasurement contracts, and in those kind of arrangements, what you're doing is you're fixing the rates that you're going to get paid for any particular activity, but it allows the quantity of the work to fluctuate. And unless there's any absolute vast difference in quantity between what you've priced and what you've ended up doing, then you'll tighter those rates. But then what you go and do is you start with that blank piece of paper and say, you start from scratch on measuring the quantities of work you complete. So this sort of acts is a good middle ground. The contractor gets a good level of certainty of price, providing his quantities are correct, and you get the certainty of, you know, how much you're going to get paid per square meter, linear meter or whatnot of your pieces of work, but you don't have the risk and carry the burden for getting the take off right, and have to factor in any additional provisions to cater for that risk that you got the quantities wrong yourself.
Jacob Austin (00:06:53) - And then the complete opposite to the lump sum end is of course, your cost plus arrangements. And these are the sort of jobs where perhaps the scope is a little bit more fluid, and all you're essentially doing is agreeing a fee. Now, in some instances that might just be an overhead and profit fee, or it might be a fee, including some management costs. The details on this kind of thing are very much on a job by job basis. Obviously, the more that is included in your fee, though, more risk that you're holding, but on the basis that the rest of your price is then allowed to fluctuate, it's very little risk to hold at all, really, but you may want to structure your fee so that it just allows for overhead and profit. And then you allow a time based valuation of certain other aspects, such as your time site managers, time contracts managers, time health and safety man, and all of these things so that as and when the duration of the work fluctuates, you've got an adequate mechanism to value those changes in period without affecting how much you're going to take home out of the job.
Jacob Austin (00:07:51) - At the end of the job, you'll be left with a list of costs that you've incurred, plus any bits that you price in agree, i.e. those bits of contracts, management time, and so on that you might have retained as a time based valuation. Plus then your overheads and profit which will be the fee including anything else. Hopefully you can see how the risk profile changes from under the lump sum. You, as the subcontractor, hold all of the price, risk and opportunity through to under a cost plus contract. You're only holding the risk for those bits that you solidify as part of your agreement, i.e. your fee and any fixed or time based rates. And the rest of it. Your contractor is holding the risk for the next place you want to start looking is your scope of works. Now a lot of scopes of works list out various things that can be quite easily and readily quantified, and those items you do hold some risk for, but it's the risk that you get the quantities correct. There are other items that fall within the scope, or certainly of a typical scope, where the contractor is asking you to price and hold the risk for certain unknowns, and this might be bits of work that they usually see happen on a site.
Jacob Austin (00:08:56) - They're not necessarily easily quantified, say, bits of patching or bits of boxing or bits of soft ground that they might need you to fill in for them. Those bits of risk might be informed by some of the design information that they've got, or they might be informed by some of the survey information that they've got. Now, I couldn't go into a full list of everything that might crop up on a job on a podcast episode like this, but what it might be sensible for you to do is to get your scope out and highlight through anything that you can't fully measure and you can't fully allow for just from the drawings. These are the kind of things that some contractors want to gain cost certainty on, and they're willing to pay you a premium for you to hold on to that risk. Now, of course, the problem with that is it's both a risk and an opportunity for you, because obviously if it doesn't come off, then you can pocket the allowance that you've made for it. But if it does come off, it might be a bigger item than what you've allowed for.
Jacob Austin (00:09:52) - You've got certain other things that your scope might ask you to include for, such as particular methods, prescriptions on supervision, prescriptions on how you can lift or excavate, which might change how you would typically approach a job, might introduce more risks. How much can you get done in a day with a particular piece of plant, and therefore, how many visits are you going to need? And those kind of things can be visible, but hidden risks if you like, because it might depend on how many faces of work you can get access to at any given time as to how productive you can make that particular piece of plant. And whilst you can allow for it in one fashion, your allowance might not be adequate unless you can achieve the particular output that you've priced upon. Of course, elsewhere in your contract you've got the. Drawings, perhaps where the psychopaths. You might be responsible for certain discrepancies and methods of work to suit those discrepancies. And where that is the case, what you need to do is assess all of those drawings to de-risk your situation.
Jacob Austin (00:10:49) - Or again, you might allow some kind of a risk, some for unforeseen eventualities. Further places in your order are the time periods. And of course, not only have you got the supervision, accommodation and those other time related costs that you need to allow for, you've also got the risk of liquidated and ascertained damages. And of course, the management of that is down to whether you can limit your exposure to any of those. And as well, it's down to how you manage your subcontract and how you cover off any extensions of time that you need. And this is rather than limiting your risk, because the time aspect of the subcontract and making sure you've got sufficient time before the completion date gives you a stay of execution for any liability on lads, other risks that you're likely to carry, or perhaps design risks. Obviously, if you aren't doing any design, that's not going to apply, but you've obviously if you are designing, you've got the risk that that works and that it stands the test of time over the latent defect period.
Jacob Austin (00:11:45) - To a lesser extent, you've got insurances. Obviously there is some risk when you are taking out insurances, but to a large degree those are backed off so far as your policy covers to the insurer. And you might have some other risks which are introduced by the likes of bonds or collateral warranties. But typically these are put in place for the right reason. And rather than introducing more risk, they can be used as a measure for you to manage the risk that you've got. In the case of bonds. And by and large, collateral warranties tend not to introduce any more risk than you are taking under the subcontract itself. Anyway. Now, beyond all of these things, you've then got the pure unknowns, those things that you've only priced because you've written, that you've priced it all risk lump sum, but that nobody really would have foreseen given the site. And given the scope of work. And there is almost always that unknown element that just nobody would have thought of. Some of this crop up into your subcontract for different reasons.
Jacob Austin (00:12:39) - Some contractors really like the idea of being back to back with the main contract on all different manner of issues, and sometimes you've got to question the contractor as to whether that is worthwhile for them to do. Say, if you've got a risk that happens one out of 100 times, and then the cost of that risk is £10,000 across the hundred projects or so that it might take for that risk to occur. If he does nothing about it, it costs him £10,000. If you offer to take the risk on that and you charge them £1,000, one out of 100 times, you lose £9,000, but 99 times you make £1,000. And to the contractor that looks like they've spent £100,000 to mitigate a risk that was only ever going to cost them £10,000. And sometimes it's that kind of lack of understanding and lack of judgment over the probabilities that caused the contractor to spend a lot more money than he needs to, particularly if you can think about managing out that risk by changing bits of the design. Of course, there are plenty of examples under a typical project where it makes absolute sense for the subcontract and the contract to be back to back.
Jacob Austin (00:13:42) - All of the different sections of work defect periods, elements of day work rates, measured, works rates, retention, release and so on. These are all good places for the contract and the subcontract to have that back to back arrangement. So having spoken about how these risks can occur, and this is again one of those cases where it could be anywhere, what you then need to have a think about is identifying them and considering how likely they might be to impact your job earlier in the process, that you can do this the better, because you've got more chance of sharing some of that risk with the main contractor. So ideally, you want to start thinking about the risks at the point that you start pricing the inquiry. This is also the place where your risk profile is the highest. It's at this point where nothing has happened yet that you've got the maximum probability that any one of the risks could come off, but this is the best stage for you to read the documents start to build a picture of what you're being asked to do, and start to build a picture of how much risk you're being asked to hold, and indeed, whether you want to hold all of it, or whether you want to try and qualify some of that out and pass the risk back to the contractor and all of the things that we've spoken about earlier, the places where risks can crop up, the places where you want to start reviewing.
Jacob Austin (00:14:57) - So it really is a case of reading the documents, understanding, and then building on that with some further brainstorming of what you might have seen happen in the past. Obviously, there's no guarantee that just because something happened before that it's going to happen again. Just because it snows on the 1st of December doesn't mean it's going to snow on the first of every December, but maybe it points you in the right direction and says, oh, it's December, there might be some snow, we might lose some time. And of course, the benefit of looking back in time at some similar examples of work is that you've also got the benefit of knowing how much it costs you on a previous job, which moves you into the next sort of category of once you've identified as. Rest as you can. You want to try and put some numbers to them so that you can identify one, how much they're going to cost, obviously best guess. And two, how great you think the likelihood is that this risk is going to come off.
Jacob Austin (00:15:48) - You want to describe in as much detail as you can what the risk actually means, what it means to you. And this will help you to build up the probability and build up a cost for it. And this is your pre mitigation cost. Now you can start assembling your risks into a table so that you're getting a schedule in order of impact of all of your risks. And within that you should be identifying opportunities or benefits as well. And doing that helps you to manage the process, because at the same time is assessing the probability that certain things don't come off. That can generate a bit of a fighting fund for risks that might come off. Some people like to multiply out the likelihood and the cost impact to give an overall impact figure. Some people like to score the cost so that it comes on a, say, 1 to 10 scale, and that gives then a risk score, which you can use to decide which risks are going to be the biggest problems here, which is worth focusing my attention on.
Jacob Austin (00:16:45) - And how can I protect myself the most by focusing on what area? So once you've done that activity and you've developed your table and you're ranking them in the highest score to the lowest score, this is the point when you start thinking about mitigation and applying some deciding factors of whether you want to control, avoid, reduce, or accept the risk. When you're talking of accepting a risk, you're basically just saying, okay, this is going to happen and you accept the consequences of it happening. And with all of the other choices, you're deciding on a kind of measure of mitigation. So if you're avoiding this might be avoiding working on a particular kind of contract. This might mean clarifying out some risks, or it might mean a kind of mitigation measure whereby you change your methodology to something that exposes you to the risk in a slightly reduced fashion or hopefully reduce it altogether. Of course, that might be a mitigation that costs you more money, but it's considering these kind of options that put you in a position of power and a position of increased certainty.
Jacob Austin (00:17:47) - So the other mitigating measures are controlling and reducing the risk are addressed in a similar fashion. Once you've done all of these things, you're essentially as informed as you can be, and now is the time to have your conversation with your contractor. Ideally, this is pre order being placed and you can either discuss, debate and agree on various bits of risk, who is the best person to hold them, and how much money might be exchanged for the person that carries them. There are risks that might sit with other subcontractors that you're able to identify through your experience in your thorough examination. And again, this might be something that you can clarify out. It might be something that you can agree with the contractor that they will buy into somebody else's package. And by doing that, perhaps save you both a cost. If you've already got the order and you're doing this review, the best time is now to discuss them. The risk that is with the contractor. I'm saying the first best time is before you start.
Jacob Austin (00:18:41) - The second best time is now. If something can be done to mitigating risk, but you've never had the conversation about it, then, then you'll be kicking yourself later and sometimes that will be an expensive kick. Risks are not spoken about enough in construction projects, and it's sometimes one of those things that is seen as a bit of a nice to have. But some of the more contemporary contracts, such as the annex of the world, force you to do that force you to raise early warnings, which then get entered into the risk register. And there are consequences for not notifying risks at the right time, because if it's known that something could be mitigated, it was never raised as an early warning, then the contractor can come in and make an assessment, as if he'd be given the choice and the chance to put a mitigation into place. These conversations aren't always straightforward, but the more you discuss the problems that you're likely to come up against, the greater the chances are that you can get the issues resolved before it starts becoming a problem that bites you.
Jacob Austin (00:19:40) - So do your review. Do your review early, and if you can't do early, at least do it now. If you want to read more about risk management, there are various places that you can look for some really good in-depth information on this. The government has produced the Orange Book Management of Risk Principles and Concepts, and also the international standardization organization ISO have created their own template and own guidance, which is ISO 31,000. And both of these will give you further information and further strategies to manage risks that you come up against in construction.
I hope that's been a help to you today. My mission with this podcast is to help the million SME subcontractors working within our industry. If you've taken some value away from today's episode, I'd really love it if you could share that value with someone else who would benefit from hearing it.
And thanks for tuning in. If you've liked what you've heard and you'd like to learn more, please do find us at www.QS.Zone where you can subscribe to our training support system for like minded subcontractors. In there you'll find templates, how to videos, interviews, and more. And it's less than the price of a cup of coffee per day. You can cancel any time.
We're also on all of your favourite socials at QS.Zone. Thanks again! I've been Jacob Austin and you been awesome!
